Earnings Call: H1 2015

Jul 30, 2015

Good morning, everyone. Welcome to our webcast. I will provide an update on our business environment before handing over to Pete for the financial details. We will then take questions. We closed 2014 with good momentum across the group. In the first six months of the year, we have seen further good performance, as well as indications of a generally improving market environment. We have demonstrated resilience driven by efficiencies and focused investment to protect our core franchises over the longer term. We expect to continue to perform well as those markets stabilize. Challenges, however, remain. We need to win order intake in our military air business to maintain continuity of production. I am confident in the capability of our products and that we can also meet affordability challenges. As flagged earlier this year, we have an increasing gap in workload at our naval shipyard in Melbourne. We continue to pursue a solution with the Commonwealth but have not yet been able to establish an Australian naval industrial strategy as we have in the U.K. For some time now, we have pointed to the high level of order intake outside of the U.K., U.S. We are seeing good growth in our missile joint venture, MBDA. In addition to our own strong Gulf positions, MBDA has also been a major beneficiary of recent French aircraft sales in Egypt and Qatar. Our share of MBDA orders from those two contracts alone will exceed EUR 1.2 billion. In fact, on top of the GBP 1.7 billion of order intake outside the U.K., U.S., we also have GBP 1.3 billion of orders being finalized. Support to our equipment on military operations in the Middle East has been intensive, and the availability of the aircraft high, testament to both the equipment and long-term progressive relationships that exist. We have been operating in the Kingdom of Saudi Arabia for close to 50 years. Overall, the group's first half performance supports our expectations for top-line growth this year. We continue to anticipate marginal growth in underlying earnings per share this year, despite the lack of earnings accretion from share repurchases. That growth outlook remains conditional on military air orders and the review options for our Melbourne shipyard facility. The market outlook in the U.S. is starting to clear with some encouraging signs of a return to growth in budgets. We will wait to see how these develop into hard procurement before amending our plans. Our U.S. defense electronics business is performing well, with substantial new business opportunities in the electronic warfare, electro-optics, and ISR defense sectors. F-35 deliveries will also increase significantly over coming years. Our commercial aerospace electronics business also continues to develop well. The business has been selected to provide the Remote Electronic Units for the new Boeing 777X. With this award, in addition to previous equipment awards in this aircraft, we will now be providing the complete suite of flight control electronics for the aircraft's fly-by-wire system. The U.S. interior, notwithstanding market headwinds. In April, a strategic review commenced to examine whether greater value may result from disposal of one or more of the group's manpower and services businesses. This review does not include the technology product-focused Geospatial Intelligence division. It is important to note that a transaction will only occur if it creates value for our shareholders. As anticipated, the group's U.S.-based combat vehicles business is stabilizing after several years of customer contraction. Following the award of the Armored Multi-Purpose Vehicle contract at the end of last year, another strong franchise combat vehicle programs, the medium-term outlook in our land sector is improving. In the naval domain, our U.S. Navy ship repair business is performing well, and the U.S. commercial shipbuilding business, for which charges were announced last year, is making operational progress. Three of the eight vessels have now been accepted by their customers. These commercial contracts will, however, remain challenging until completion of all the ships in 2016, particularly in our Alabama facility, where competition for skills is high. The U.K. businesses continue to perform well, with much of our business subject to long-term plans and contracts. The recent budget announcements are supportive. The GBP 500 million reduction in the current year defense budget is not expected to materially impact programs in which the group is engaged. A Strategic Defense and Security Review is anticipated later this year. The current expectation is for continued stability across the group's large platform and support program activities. In the air domain, our U.K.-based production of rear fuselage assemblies for the F-35 aircraft is set to increase significantly over coming years to meet the requirements of the program for both the U.S. Armed Forces and international customers. Typhoon aircraft deliveries to the Royal Air Force and the Royal Saudi Air Force continued alongside airframe sub-assembly deliveries for our European partner nations. The release of additional capabilities for Typhoon aircraft is progressing at pace. This includes clearance of additional weapons onto the aircraft, as well as E-Scan Radar development. In addition, we continue to provide extensive support and upgrades for aircraft in service with the Royal Air Force. In the naval domain, we have a large order backlog and good long-term visibility, benefiting from work over recent years to develop, with the U.K. government, a coherent industrial strategy for the U.K. naval sector. The Queen Elizabeth Class carrier program progresses with assembly of the second ship well underway, alongside systems integration and commissioning on the first of class. Following the renewal of the multi-year agreement to manage Portsmouth Naval Base, we are progressing plans with the Royal Navy for the support and basing of the two new carriers at their intended home port in Portsmouth later this decade. In February, the U.K. government announced its commitment to the Royal Navy's new Type 26 frigate program. Consistent with the U.K. government strategy for naval shipbuilding capability, we are progressing the build of three Offshore Patrol Vessels. These vessels not only sustain key skills, but also drive de-risking of the follow-on Type 26 program. Infrastructure investment required in support of the proposed Successor submarine program, expected to replace the Royal Navy's Vanguard-class boats, has been agreed and work commenced at BAE Systems' Barrow facility. Artful, the third of seven Astute-class boats, will exit Barrow later this year, a major milestone for the program. There are 1,500 people working on Successor and some 7,000 people operating in the submarines business overall. In Saudi Arabia, we continue to support our customer in addressing current and future requirements. We are seeing a high volume of support and urgent operational activity, reflecting the high tempo of operations being conducted by both Typhoon and Tornado aircraft. The equipment supplied by the company is achieving high levels of availability. We now have 5,600 people working in Saudi, of which 61% are Saudi nationals. We are being recognized for our contribution to the Saudi national agenda. We are facing a challenging outlook in our Australian naval shipbuilding business as we run off from a high volume of activity on the successful Landing Helicopter Dock program. We are facing an increasing gap in workload at our naval shipyard in Melbourne. The group is reviewing options for the facility and to mitigate the impacts. BAE Systems holds a 37.5% interest in MBDA, the Pan-European guided weapons business. The high level of order intake for equipment to support Tornado and Typhoon aircraft in service in Saudi Arabia is contributing to the good growth now anticipated in MBDA. In addition, MBDA has been a major beneficiary of recent French aircraft sales in Egypt and Qatar. We continue to address opportunities in our international markets. In India, we have seen some renewed activity on a prospective contract for M777 howitzers, and we are commercially negotiating the next batch of Hawk aircraft. Work progresses to plan on the Omani Hawk and Typhoon contracts, and we continue to pursue other international prospects for these platforms. We enjoy renewed strong support from the U.K. government in pursuing export opportunities, key when you're engaged in these types of campaigns. A real plus from the clear U.K. election result. We continue to address the growing cyber market through our Applied Intelligence business. This is a fast-moving space, and we are moving rapidly to address it. The SilverSky acquisition has gone well. It is a key part of our strategy to develop and grow a position in the expanding commercial cyber market, building on our government cyber credentials. SilverSky is now an integral part of our Applied Intelligence commercial solutions division. We are also undergoing a rapid organic expansion, having recruited some 900 people in the first half of the year, and expensed over GBP 50 million on product and market development. Prospects for the business are good, and we have a very active pipeline of new business we expect to secure in the second half, and which supports our full-year expectations for strong growth. I will now ask Pete to take you through the financials. Pete? Thanks, Ian, and good morning. As usual, I'll step through the results for the half year, and then I'll move on to the 2015 full-year guidance. The results have seen some benefit from the stronger US dollar, and for reference, the dollar rate has averaged 152 so far this year, compared to 167 last. The headline numbers, and compared to the first half of 2014, sales increased by some GBP 900 million to GBP 8.5 billion. Around GBP 200 million of that increase was due to exchange translation, and we continue to expect some second-half bias in sales due to the contracted schedule for deliveries into the Kingdom of Saudi Arabia this year. Underlying EBITA of GBP 800 million was almost unchanged from last year, and that includes a GBP 21 million translational exchange benefit. Underlying finance costs in the first half were higher at GBP 107 million, largely for the cost of carry of the $1.1 billion bond pre-financing that we put in place in October last year. Underlying earnings per share were GBP 0.171, and the reduction of GBP 0.006 was largely as a result of that higher finance cost. There was an operating cash outflow in the first half of GBP 349 million, and net debt at June 30th stood at GBP 1.9 billion. I'll cover the cash position on subsequent charts. Order backlog has reduced to GBP 37.3 billion, of which GBP 0.5 billion is due to exchange translation. Finally, the interim dividend has been increased to GBP 0.084 per share, up 2% on the 2014 interim. There are a number of items impacting the balance sheet, in particular, working capital in the first half of the year. As anticipated, advances continue to be consumed on the Omani Typhoon and Hawk program, the European Typhoon contract, and the Saudi training aircraft contract. The second of the two payments under the Project Salam settlement has now been received. Costs are being incurred against a number of provisions created in previous years, including the U.S. commercial ship build program and on U.K. rationalization. The IAS 19 accounting pension deficit is reduced over the six months to GBP 4.8 billion. That pension deficit reduction also reduces the deferred tax asset. I'll move straight on to the pension deficit position on the next slide. The value of the scheme assets is unchanged since the start of the year at GBP 23.8 billion, and that's after pension benefits paid out of some GBP 600 million. Liabilities reduced by GBP 0.6 billion to GBP 30 billion. Real discount rates have increased by 10 basis points in the U.K. and by 40 basis points in the U.S., mainly driven by slightly higher bond yields. The period discount unwind and pensions paid broadly net out. Overall, a net GBP 600 million decrease in the pre-tax accounting pension deficit. As you know, the pension accounting is not the important issue, it's the funding position that's most relevant. Following last year's triennial funding agreements, as previously advised, cash payments this year into the schemes against those deficits will be similar to last year, totaling close to GBP 400 million. Moving on to cash. This slide sets out the movement from our net debt position of GBP 1,032 million at the beginning of the year. There was an operating business cash outflow of GBP 349 million. Interest and tax payments were GBP 154 million. 2014's final dividend, paid in June, was GBP 389 million. Since commencement of the share repurchase program, we have bought back 120 million shares at an average price, including costs, of GBP 4.16. As with all uses of capital, we apply strict criteria to the share repurchase program. We consider the return generated from the cash dividend that we save, rather than the earnings per share accretion. Clearly, those returns diminish the higher the share price. As a result, activity on the program has been minimal in the first half of the year. All the other cash flow movements totaled GBP 11 million, we closed at June 30th with gross debt of GBP 3.3 billion, cash of GBP 1.4 billion, and net debt of GBP 1.9 billion. $750 million will be repaid in August in respect to the first of the two pre-financed long-term maturing bonds. The cash flow performance of the five sectors is shown here. I'll return to this when I cover the results of each of the sectors. Just to note, the total cash outflow for pension deficit funding in the period was GBP 186 million, and the cash outflow at head office contains GBP 160 million off that. Moving now to the sectors. I'll cover the year-to-date performance here and then return to the full-year outlooks a little later. The first of those sectors, Electronic Systems, and the numbers here in U.S. dollars. The sector delivered sales of $1.9 billion, 3% ahead of last year. Sales in the commercial areas of this business now stand at 23%, and growth in the first half was 12%. Sales on the defense side were stable, with growth on the F-35 program offsetting contracts completing in 2014. The return on sales achieved of 15% was also ahead of expectations and well up on the first half of 2014, benefiting from strong program execution across most business lines. Cash conversion of EBITA in the first half year was better than last year. We do expect an improved conversion level over the full year. Order backlog stands at $5.8 billion, slightly down since the start of the year. That's pending a number of expected second half awards. The Cyber and Intelligence sector comprises the U.S. intelligence and security business, together with BAE Systems Applied Intelligence. The numbers again here in dollars. In aggregate, sales were almost unchanged at $1.35 billion. The U.S. business saw just a 2% decrease, in line with the expected further reductions in IT services. Growth in the Applied Intelligence business was 16%, benefiting from the acquisition of SilverSky at the end of last year. The business has seen some delays in short-cycle order awards as the pipeline has developed. This has constrained sales in the first half year. Margins of 5.9% reflect the expensing of the integration cost of SilverSky and the accelerated product development costs and sales team buildup in Applied Intelligence in support of our full-year growth expectations. Order backlog again increased to $3.2 billion. Despite the first half top-line pressures, backlog in the U.S. business grew marginally on securing a large classified program award. In the Applied Intelligence business, after adjusting for exchange translation, backlog grew by 6%. In the Platforms and Services U.S. sector, in line with our guidance that we gave back in February, sales in the first half year reduced by 12% to $2 billion. That reduction comes from last year's completion of the Ground Combat Vehicle development activity. Recognizing the disposal of the South African land business and exchange translation, the sales reduction was 9% on a like-for-like basis. Margin performance for the first half year is also per guidance at 6.9%. Cash flow is being impacted by the utilization of provisions created against the U.S. commercial ships programs and of customer advances on the CV90 Norway contract, along with investment on the new floating dry dock in San Diego. Order backlog is reduced in line with the sales traded on the long-term Multi-Ship, Multi-Option contracts in the naval ship repair business. In the Platforms and Services U.K. sector, sales were at GBP 3,544 million, up 25% compared to the first half of 2014. Whilst European Typhoon deliveries have a much more balanced profile this year, on the Saudi program, there are four aircraft deliveries in the first half and nine scheduled in the second. One point to note, the business is contracted for the supply of the radar and DAS equipment for all 88 of the European Tranche 3 aircraft. This was not the case for Tranche 2, and this has added incremental sales recognition of some GBP 300 million in the period, albeit the group only takes a small handling fee on this minimal risk element of the contract. With regard to the return on sales, you'll recall that the 13.8% seen in the first half of 2014 benefited from strong program execution and risk reduction on the European Typhoon Tranche 2 production as deliveries moved towards completion. We're now delivering against the Tranche 3 contract. The dilutive impact to the return on sales from trading of the radar and DAS equipment is around 50 basis points. As expected, the GBP 296 million of cash outflow in the period reflects the consumption of customer advances on the Omani Typhoon and Hawk program, the European Typhoon contract, and the Saudi training aircraft program. There have also been rationalization costs charged against the provisions created in prior periods. Order backlog reduced to GBP 18.7 billion, primarily on the trading of Typhoon aircraft, Carrier, and Astute. Sales in the International business for the first six months of GBP 1,621,000,000 are 6% higher than in 2014 on a like-for-like basis. The delivery of weapon systems to the Royal Saudi Air Force and milestones on the Australian Landing Helicopter Dock program are weighted to the second half. EBITA was GBP 155 million, giving a broadly consistent return on sales of 9.6% after taking a small charge of GBP 5 million for some 200 redundancies announced at the Williamstown shipyard during the first half year. There was an operating cash outflow of GBP 49 million, which does include the second payment under the Salam BOP agreement. You will recall that some GBP 200 million of receivables were collected in December last year ahead of the contracted due dates. Order backlog is at GBP 10.7 billion on the trading of our five-year Saudi support contracts. For reference, there's a chart providing a summary of the trading performance of all five of the sectors and the numbers for HQ appended to the presentation posted on the web. Turning to guidance, this chart you'll be familiar with from our February results, and it sets out the guidance for each of the sectors through to the end of the year. Of those five sectors, guidance has only materially changed for one, so that's the one I'm going to talk about. In the Platforms and Services U.K. sector, sales are now expected to increase by close to 10%. There are 13 Salam Typhoon deliveries planned against last year's 11, and the Typhoon Tranche 3 deliveries of radar and DAS equipments that I referred to earlier were not previously included in the guidance. In the naval domain, we expect higher sales from the activity on the Astute and Successor programs to more than offset the reducing carrier trading. Margin guidance is unchanged. That is at the lower end of our 10%-12% range, being impacted by some GBP 35 million of higher pension service costs compared to last year, as well as the margin percentage dilution from trading of radar and DAS equipments. Guidance for the headquarters charge, underlying finance costs, and effective tax rate are also unchanged. Overall, we continue to expect the group's reported earnings per share to be marginally higher than in 2014, despite the lack of earnings accretion from share repurchases. That growth remains conditional upon anticipated aircraft orders and review of options for the Melbourne shipyard facility. This final chart highlights the cash utilization we expect in 2015. The first column shows the position at the half year. The second column provides the full year guidance. In respect of operating cash flow, we are not planning for any material capital expenditure above depreciation levels, and within working capital, we expect to incur costs of around GBP 200 million against provisions created in previous years held in the balance sheet. The most volatile area, as always, remains the level of customer advances, and as expected, against the major advances we received in 2012 on the Saudi trainer aircraft contract and the Omani contract, we are seeing a high level of utilization. You will recall that under the terms of that Omani contract, no further cash will be received until deliveries commence in 2017. Advances are also being consumed on the European Typhoon production program. The final operating cash flow item is the year's pension deficit funding, which will again be close to GBP 400 million. The non-operating cash flow items are far more predictable. Outflows for interest and tax are expected to total around GBP 300 million, and dividends will be close to some GBP 0.7 billion. Purchases under the share buyback program will be made where they deliver value for the shareholders, and as I mentioned earlier, we apply the same stringent criteria to share repurchases as we do to all other capital allocation decisions. Under the transactions announced last year, we have had receipts now from the disposal of the land business in South Africa, and we expect receipts in the second half from the restructuring of our Saudi partner companies. In total, we continue to expect net debt to increase in 2015, albeit with some volatility around advanced payment on contracts. Just to be clear, this guidance does not anticipate any possible disposal transaction relating to the group's U.S. manpower services business. On that point, turn it back to you, Ian. Thanks, Pete. In summary, the group continues to perform well with a large order backlog. With some anticipated trading weighted to the second half, we remain on track to deliver top-line growth and subject to the previous flagged conditions, marginal growth and underlying earnings per share this year. In recent years, we have developed a robust services business, leveraged our capabilities in adjacent growth markets, and maintained disciplined cost control. We have also continued to invest in developing skills and new technologies for the future. These actions have provided resilience through an extended period of reduced defense spending in some key markets. BAE Systems is well-positioned to benefit from a generally improving market environment. Thank you. We will now take questions. Who's first? No questions? I don't believe it. To ask a question over the phone at this time, please press star one. Sorry, couldn't really hear that. To ask a question over the phone line, please press star one. Rami, do you have a question? We will now take our first audio question from Rami Myerson of Investec. Please go ahead. Good morning, gentlemen. Can you hear me? Yes, we can hear you loudly and clear, Rami. Excellent. Two questions, if I may. First, on Eurofighter production in the medium term. Can you talk about what your plans are if some of these export orders do not materialize, and you decide together with the partner nations to extend the production of Eurofighter at lower volumes? The second question. Post the budget announcement, I appreciate that we are still ahead of an SDSR, but given there's going to be growth in U.K. defense spending, do you see areas where you may increase investment or potentially do acquisitions to position yourself going forward? Two questions, right. First one is on maintaining production rates on the Typhoon line. Was that the first one? Yeah. What type of production rates do you expect to see- As we talked before going forward, how that will impact profitability? Okay. I think as we told before, is that we have a line today which does 30 a year. What we've said is that if we needed to reduce the capacity on the line or the throughput on the line to sustain the continuity of production, that's what we'd do, and we'd make that decision in the final quarter of the year, depending on where we are with orders. That's still the plan. We're still going for plan A, as we explained previously, at the moment, we're out with the supply chain saying cheaper, faster, we don't want to have to go out with a different set of messages and talk about a slowdown to maintain continuity. That's where we are, and that's a final quarter decision. In terms of the SDSR, well, I think going into an SDSR with an agreed budget is the first time in my tenure in this company where we've had that position. We have some more stability. I think the important thing is, this goes back to the manifesto of the Conservative Party, is the GBP 163 billion of commitment over the next 10 years on defense procurement. That's the thing which provides us stability on our programs. Areas where we will focus on is technology areas that we're spending in the U.K. remains our core business of combat aircraft and, in fact, unmanned technologies. I think we do not spend an awful lot of money sustaining capability in nuclear submarines because we provide that capability to one customer only. The fact that there is a consistency in budgets going into a strategic defense review, I think is the most comfortable position we've been in for a while, as the government determines what capabilities it wants for the future, is the consistency because it feeds off what they did previously in the 2010 SDSR. I think we are going to get a lot more visibility and stability on the core programs going forward. Do you think there will be areas where you may have to increase investment, cybersecurity as an example? There may be areas where we would have to increase emphasis on existing spend, which with clearly security and unmanned aircraft, if there were programs defined that required that, we're flexible and we have the capacity to do that. Okay. Thank you very much. We will take our next audio question from Christophe Menard of Bernstein. Please go ahead. Yes. Hi. Good morning, gentlemen. Good morning. Just a quick high-level follow-on, on SDSR, if I may. Yeah. Your commenting on the budget stability or providing at least some clarity versus last time were helpful. In terms of process of the SDSR so far that you've observed compared to 2010, is there evidence that suggests either through better government communication or otherwise, that you're, I guess, more bullish, for lack of a better descriptor, on a more orderly process in determining where some cuts and adjustments will be made? As a corollary question to that, are there particular programs, platforms or domains of concern that you're particularly focused on going into the autumn? It's a great question. It certainly is a lot more orderly than we went into the previous SDSR, when it was unclear as to budgets and what engagement there would be within industry to define capabilities that are required. We are much more comfortable with the process. Because it's a continuum from the 2010, it's a much more structured review that they're going through. In terms of their focus on platforms and systems, I think that we have pretty good visibility, and we don't expect anything that is going to come out of that, which is a real change in momentum that they've had previously, is probably the best way of doing it. We are not expecting a huge number of surprises. Okay. Thank you. We will now take our next question from Ed Stacey of Berenberg. Please go ahead. Hi. Just firstly, sort of taking a break from U.K. budget. MBDA. I see some headlines this morning that you were talking about the Finmeccanica process. I just wonder with MBDA, what are the possible outcomes that you'd consider in terms of, do you end up as a minority with Airbus being the majority, or do you talk to Airbus about getting yourself squeezed out of MBDA entirely? What are the options that are realistic for you to look at? There's a very simple answer to that question, and it is that MBDA is a core part of our portfolio, a very strategic part of our portfolio. We have rights under the original agreement, which means that we have preemption rights so that we cannot become a minority partner, and we will not become a minority partner in that joint venture. Great. That's very clear. Back to U.K. budgets again. The Successor submarine is a very big program. Previously there was talk that is excluded from the baseline procurement budget. I think we're going into this SDSR with Successor funding has to come out of the baseline procurement. In answer to one of the previous questions, you said that you don't have any big areas of concern. It seems to me like there must be a big squeeze on some area or other in order to accommodate Successor. Am I wrong in that thinking, or how do you think that you guys are going to- I'm not sure you're right in that thinking. It has been in their plans. It was in their budget assumptions going forward. I don't think there is an intention that it's taken out of the defense budget. It's a fundamental portion of the spend going forward. It's within the baseline procurement budget that they're going to fund Successor. If that's a big new thing kicking in, there must be some big thing that they can cut back on. It was always in their assumptions going forward. Okay, got you. Thank you. We will take our next question from David Perry of JPMorgan. Go ahead. Yes. Good morning, gents. Two separate questions, please. The first one is, could you just give us the two potential caveats to hitting the full-year EPS? Is it possible to put some numbers around those just so we can have an idea of the magnitude? I heard, obviously, the previous answer on Saudi, but I guess the profit recognition this year wouldn't necessarily have to do with giving us your thoughts on next year's production rates. Just what the sensitivity to Australia and Saudi might be this year. The second one, Peter, is I'm just a bit confused by the messaging around the share buyback because, and I may be wrong here, I haven't gone back and looked at the transcript from February. Back in February, the share price was, I think, around GBP 5.20, but you had the GBP 400 million outflow for the buyback in your slides as part of your cash flow for the year. Something has changed in terms of the way you think about it, and I'm a bit confused as to what that is. Thanks. I'll let Nick cover Australia and the share buyback, and then I'll come back on Typhoon. Yeah, fine. On Australia, the issue there is around the review of the options of the facilities in the Melbourne yard. In terms of, is the number material to the group? Not really. Our guidance is for marginal growth in earnings, then the sensitivity is to that marginality, if you understand that point. That's the sort of issue with Australia. It's not a big number. In terms of the buyback, as I said, the key for us on the buyback is delivering value for the shareholders. When we announced this buyback program, going right back to the beginning, the share price was down at GBP 3.20. The way we look at the value is from the future dividends that you save from buying back shares. Clearly, the higher the share price, the lower the return. We want a return that's going to at least be more than WACC, we look at the return on an IRR basis. We will continue to buy tactically when we see share price weakness. If the next question is going to be what's the share price, I'm not going to give you that number. It's all about value for the shareholders. When we come to Typhoon production rates, David, as you know, we have long-term contracts, and we trade prudently over those long-term contracts. If we have to slow down manufacturing on those existing contracts to maintain continuity, there will be an increased cost associated with doing that, which will impact the average return on the program, which would mean it would impact profit in this year. Can you- We are not going to- How much? We are not going to quantify that number for you. Okay. Thank you. We will now take our next question from Robert Stallard of Royal Bank of Canada. Please go ahead. Thanks so much. Good morning. Hello? Robert, we can hear you. Morning, Robert. Okay. Morning. I saw a couple of questions on your largest end market, the U.S. The FY16 budget appears to be coming together better than expected. Given on what you see today, where do you think the positive impact could be on your business? Secondly, obviously you've announced this restructuring or consideration of strategy in the U.S. What's been the initial reaction to that announcement? Have there been any potential buyers knocking on your door? Thanks. Why don't we ask Jerry to cover the FY16 budget, I'll talk about the process that we're going through on the assets in the U.S. Jerry, face the camera, as they say, or cameras in this case. Good morning, Robert. How are you? Good, thanks. With respect to the U.S. Defense Budget in FY 2016, as you know, the President submitted a budget that's about 5%-7% above the Budget Control Act caps. In addition, both houses, both chambers of Congress, have passed budgets at about a similar level. That's very encouraging. In terms of support, a number of our key programs are included in there, from the F-35 to our entire electronic combat suite, some very key programs in our combat vehicle business, ship repair and modernization, as well as even our munitions business. We're very pleased to see that our portfolio is very relevant to those budget submissions. With respect to going forward, as you know, there is a little bit of a debate as to how much of that increase will be in the base budget and how much will be funded through contingency operations. That political debate, we expect, is going to run for the next couple of months. We anticipate a brief period under continuing resolution. In general, I think we, along with the rest of our counterparts in the industry, are encouraged with the trend that we now can see actually a climb out of this trough and a recognition of worldwide conditions. Thanks very much. In terms of the assets in the U.S., this process was triggered, the strategic review of the process, because of some inbound interest. We do have interest in our businesses. As we've always said, these are very well-performing businesses, and you can see in the first six months that they have performed well. We will not do anything unless this generates shareholder value. These are not businesses that we have to sell. It's not a fire sale. We did have some inbound interest, and we thought it was the right thing to do to go through the strategic review as to who's the best holder of these businesses. Thanks, Ian. Maybe just a quick follow-up on that. If you do achieve some disposals, what do you expect to do with cash proceeds? We've always said that we have a really clear capital allocation policy, and we will follow that capital allocation policy. If your next question is what are your areas of focus for acquisitions, we've always been clear in defense and commercial electronics and cyber. These are the areas that we see that we should still be looking as to whether there's businesses that we should be buying and investing in. Nothing has changed on that allocation policy and/or our areas of focus. Okay, thanks very much. As a reminder, to ask a question, please press star one. We will now take our next question from Nick Cunningham of Agency Partners. Please go ahead. Yeah, good morning. Thanks very much. All the big issues I think have been raised, that I'm aware of. There's a couple of things I'd like to just follow up on that. First one, there's been some very specific reporting around Typhoon, particularly from Jane's, saying that there'll be a production break in 2018 even if you get Salam 2. First of all, the source of that was Warton management, so obviously not good quality. Question is, what's the veracity of that, and what sort of effects does that have rippling back? Secondly, just following up on the buyback and M&A questions, is it possible to lay out what the calculus is behind the buyback rationale so that we can understand it and perhaps even have a go at forecasting it going forward? Secondly, would it be possible, sort of, if you like, U.S. corporate style, to lay out what your criteria are in terms of M&A as to what sorts of returns you look for in both earnings and cash flow terms in order to justify a particular acquisition? Also what is acceptable level of leverages as well? Thank you. Where do we send our strategic plan to then, Nick? Do you want to Agency Partners. Seventh floor. All right, Peter, why don't you cover them. I'll come back on the Typhoon question. Yeah. The buyback, if you like, give us a benchmark. What we're looking for is an IRR that's going to be better than our weighted average cost of capital. We save dividend. It's sort of relatively risk-free. Nothing in life is completely risk-free, but it's relatively risk-free. Building then on the question about how do you assess M&A, well, clearly, if you're buying someone else's business rather than your own shares, there's a lot more risk. When we look at the discount rates we'd apply when we look at another business, we put a fair bit of risk premium on top of that WACC rate. I don't think you'll find that will be dissimilar from any other company's approach. Is that for the year-3 type target, WACC plus risk? Yeah, we would normally look for year three. In your first question, Nick, I think we've been very clear for a long time that if you continue at the current production rate on our existing orders that are in our order book, then Typhoon doesn't have any orders beyond the first quarter of March 2018. That's a fact. There is also a fact that at the same time, we are ramping up production on F-35. If we had to reallocate resource, because if the timing of orders required us, we are very able and have done that many times, and we would also then have discussions with the supply chain. This is something that we can manage and is part of our core skills. Thank you. We will now take our next question from Olivier Brochet of Credit Suisse. Please go ahead. Yes, good morning, gentlemen. Good morning. Good morning. I would have three, please. The first one on JLTV, if you could update us on how you see your chances on this program. The second on the exports from the U.S., if you can give me a sense of how much of the U.S. revenues, let's say $11 billion for a rough number, would be Export related, either direct or indirect through your U.S. peers. Third, a quick question on the Typhoon margin. I understand that you don't want to give a sense of how big the impact could be if there is any change, but is it fair to say that there would be an impact coming from the lower rate in the future impacting, so a lower fixed cost absorption and a change of the past margin? Yes, as we said previously, because of the way that we trade on programs, if there's a cost, we averagely trade. If there's an increased cost, it would affect margins that we've traded, and there would be a trade back of that margin. Thanks. Yes. Jerry, I think you've got the first two questions. Sure. With respect to the first question on JLTV, it's a very competitive award. We are partnered with Lockheed Martin. We think we have a very innovative approach, but it will be a hotly contested program. I think the award decision is scheduled from the Department of Defense in late August, September timeframe. After that, we may go through a period of protest, as is not unusual on a highly competitive program. It will be some time before I think that one sorts it out. With respect to exports from the U.S. business, in 2014, 2015, we will be roughly about 12%-13% export. As we get out into our business plan over the next three to four years, we see that at least doubling and possibly even above that. Excuse me, to follow up on that, would that 12%-13% include both direct and indirect? That's correct. That's as a percentage of total revenue. Okay. Just back on JLTV, how big is that in terms of revenues for you in this contract? The initial award, it will follow as most combat vehicle programs, a 2- to 3-year development and testing program before we see any meaningful production revenue coming in. It's not that material to our plan over the next couple of years on the development phase, it would not be until the 2019, 2020 timeframe. I think it's too early to forecast exactly how the US budget would shake out. Thank you very much. Olivier, if I could just add to that. Another question. Just to be clear, the JLTV is an opportunity. It's not actually in our baseline plan or guidance. As we've said before, if we won this would be an addition to our plan. That's not to say that we're not supporting it and fully behind. 100% What Lockheed are doing. I think it's fair to say that relationship is working well, Jerry. Very well. Jerry, every time Lockheed Martin sell an aircraft, and every time Boeing sell an F-15 overseas, that has our electronic warfare on it. That's why also you have to take that into account in the, what you would call, the indirect exports. We will now take our next question from Benjamin Heelan of Deutsche Bank. Please go ahead. Yes, hello, thank you. I have two questions, both of which were related to Eurofighter and Saudi and actually other potential campaigns. The first one, your new guidance for the full year movement in customer advances, you've lowered the range by GBP 200 million. I'm just wondering what, if anything, I should read into that lowering of the advances number about your confidence on securing or not securing the necessary Typhoon export orders in Q4. The second question on Eurofighter, again, even if Saudi Batch Two does come along, clearly that gives you a help, but only 12 to 18 months further production visibility on the program. Just wondering what other realistic export campaigns and other hopes that you have in the pipeline to further extend Typhoon production even post a Saudi win. Well, I'll answer the second one. As you know, Ben, we've always talked about extending the production out through 2021, 2022. That was with the further 100 aircraft to finish the first 12 of the 12 that we got in Oman a few years ago. That is still the plan. On the advances guidance, we have shifted it slightly, but that's not really about the receipt side, that's about the burn rate in which we're building up. We are actually getting, across the whole year, we'll be about GBP 200 million higher in terms of the inventory levels that we've built, and therefore, that flows from the prepayments we already have from the customer. It's not about receipts, that's about payments. Can I also read into the range that you've given, which is still GBP 500 million wide, as the potential delta pending receipts on how those receipts may or may not pan out? Is it really that GBP 500 is due to just how the outflows go rather than how the inflows arise- It's a mix of the two. If you see what I mean. It's a mix of the two, Ben. It's a mix of the two. Okay. Thank you. As a final reminder to ask a question at this time, please press star one. We will now take our next question from Harry Breach of Raymond James. Please go ahead. Yeah. Ian, Peter, can you hear me? Yes, can hear you. Yeah, morning Harry. Yeah. Good morning. Just a couple of quick ones. Peter, I missed your comment earlier on revenue. Did you back out the first half 2015 revenue growth impact from currency and from acquisition and disposals? If not, could you share it with me? The next one was maybe more for Ian about whether you could give us any sense in your views on export campaign activity for Typhoon, not thinking about the Middle East really, more thinking about other prospects, be they in the Far East or potentially in Europe. Finally, on Applied Intelligence, I suppose the first half was a little bit slower in terms of backlog growth than we've seen prior six-month periods, and it feels from the context of the presentation that that's about phasing. Can you give us any color about activity levels in terms of order intake at Applied Intelligence in the half? Let's cover Applied Intelligence. You remember last year we did end with a huge order book. We do have quite a bit of visibility of trading of that order book, and it is second half loaded. Generally, the business is active across all of its three divisions. We have good visibility and we're comfortable with the guidance we've given. As you can see, we've recruited about 900 people. We've spent GBP 50 million on product development and market development. This is full on. They're meeting their targets on releases of new product sets. The quality of the order book, the quality of the customer base is as we would expect it. It is second half loaded. Yeah. If I could just add to that, I mean, the order book, the order backlog was growing 37% last year. You have- Yes once, if you've got it in the backlog, it's about execution. The other issue, Harry, is you remember we expense the majority of costs in this business. I think we expense about 95% of costs. It is not something that sits in WIP. It is not that type of business. No. It was just about ordering intake in the half, Ian. Harry, we had an extremely high order intake in the final part of 2014. Okay. Then export and revenue? Exports and revenues, there's a concentration on the Middle East, there are some prospects in the Far East and in Europe. You have to take these things in the round, which is why we've always talked about this 100 further aircraft of sales over a period of time. What we do is we make sure that we fund the campaigns 100% so that we're not suboptimal on the funding and the teams of people that are operating on them. On the revenue question, Harry, we were GBP 900 million up in terms of sales half-year over half-year. GBP 200 million of that comes from FX. There's very little movement around the M&A. We had the land business in South Africa, which we sold, we had the SilverSky acquisition that we acquired. The net is not much between the two. The other piece is the trading, as I mentioned, of the radar and DAS equipments, that was just over GBP 300 million in the half. You get a GBP 200, a GBP 300, then the other GBP 400 million is what I would call the normal trading from the businesses. That's clear, Peter. Thank you very much. Thanks. As there are no further questions queued at this time, I would like to hand the call back to Ian King for any additional remarks. My only additional remarks is thank you very much and have a good rest of the summer. Thank you. Thank you.